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Analysis
Brazil's prolonged political paralysis

Brazil's prolonged political paralysis

Scandal may sour appetite for reform

by Desmond Lachman in Washington

Thu 15 Jun 2017

Oscar Wilde might have said of Brazil's current political circumstances that to lose one president by impeachment may be regarded as a misfortune – to lose another in the same manner, as the country seems to be doing, looks like carelessness. The dire condition of the Brazilian economy, which is yet to begin recovering from its worst recession in 100 years, further exacerbates the challenges facing President Michel Temer.

The corruption scandal threatening Temer comes at an inopportune time. He has already lost half of his cabinet due to the recent Petrobras scandal, and his approval ratings are down to single digits. It comes less than one year after his predecessor, Dilma Rousseff, was impeached, and barely 18 months before Brazil's next scheduled elections.

Unless Temer resigns soon, belligerent impeachment proceedings may threaten Brazil with a prolonged period of political paralysis. That would almost certainly delay the implementation of the far-reaching reforms necessary to reinvigorate the economy.

The last thing Brazil needs is a further loss of confidence by both domestic and foreign investors. Over the past two years, its economic output has declined by almost 8%, and the unemployment rate has reached over 13%.

Brazil's public finances are unsustainable. The country is running a government budget deficit of 8.9% of GDP, and its public debt to GDP ratio will be close to 80% by the end of this year. Absent an early turnaround in its finances, Brazil's public debt could rise to around 100% of GDP by 2020. Rating agencies are contemplating whether to downgrade Brazilian government bonds further into junk bond territory.

The country's corporate sector is in a parlous state. Without an early economic recovery, it is difficult to see how Brazil's corporate sector will avoid defaulting on its substantial debts. This is especially pressing since a large portion of those debts is contracted in dollar-denominated terms.

To its credit, the Brazilian administration recognises how important it is to restore quickly order to the country's unstable public finances. To that end, the government proposed a multi-year public spending reduction plan in addition to deep reforms to Brazil's labour market and pension system.

However, those reforms are unlikely to come to fruition if the country becomes distracted by Temer's political tribulations. There is the real risk, too, that Brazil will lose any appetite for budget discipline and economic reform in the run-up to next year's elections.

Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund's Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.

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